Does Fixed Point Iteration Converge to the Correct Asset Price in Dynamic Models with Taxes?
19 Pages Posted: 27 Nov 2017 Last revised: 6 Apr 2018
Date Written: November 22, 2017
The price paid for an asset may affect future after-tax cash flows, in turn affecting the value of the asset holding itself. Thus, the price an investor is willing to bid depends on itself recursively, and often an analytic solution is impractical or nonexistent. We discuss the conditions under which fixed point iteration converges to the correct asset price. An intuitive economic interpretation of these conditions suggests that the procedure is generally very safe. However, we present two real-world examples in which iteration need not converge to the correct price, and suggest ways to deal with similar cases.
Keywords: asset pricing, taxes, fixed point, contraction mapping, iteration
JEL Classification: G38, H2
Suggested Citation: Suggested Citation